Written evidence submitted by the Association
for the Conservation of Energy

INTRODUCTION

The Association for the Conservation of Energy was
formed in 1981 by major companies active within the energy conservation
industry, in order to encourage a positive national awareness
of the needs for and benefits of energy conservation, to help
establish a sensible and consistent national policy and programme,
and to increase investment in all appropriate energy-saving measures.
We welcome this opportunity to comment upon the proposed Green
Investment Bank.

SUMMARY

The new Coalition Government should make a clear
and early statement that it remains committed to the creation
of a Green Investment Bank (GIB) with a full range of powers.
Although this was promised in the Coalition Agreement, no concrete
proposals have subsequently been forthcoming. Furthermore, at
the time of the Queen's Speech on 25 May, the Government stated
that the forthcoming Energy Security and Green Economy Bill might
be used as the legislative vehicle "to set up a Green Investment
Bank". We are concerned that the latest pronouncements from
the Department of Energy & Climate Change make no mention
of the Bill being used for this purpose.

The GIB should have a clear mandate to tackle the
low carbon investment needs of the UK. The scale of the required
investment is such that traditional sources of capital will fall
well short of the sums required. Without such intervention, the
UK's low carbon targets will not be achieved. Adequate levels
of initial capitalisation - around £4-6 billion - will be
required to ensure the Bank's success.

Investment in energy efficiency should be a key feature
of the Bank's activities. In particular, energy efficiency should
be given the highest priority in the Bank's initial phase, as
investment in demand reduction measures will reduce the level
of total infrastructure required and enable the scaling-up of
existing, proven technologies. Approximately £225 billion
will be required to finance the requisite energy efficiency improvements
until 2025 - this represents around half of the total low carbon
investment required.

Retrofitting the UK's building stock is a vital component
in the delivery of our low carbon future. However, this involves
large numbers of individual investments and small scale projects.
The GIB can play a key role in aggregating these investment opportunities
and providing upfront finance to householders and SMEs.

Part of the GIB's remit should be to support the
proposed Green Deal financing scheme. This will be especially
important in the Green Deal's early market stage before significant
scale of demand has been achieved. The support should take the
form of upfront loans to able-to-pay householders, complemented
by subsidies for households unable to pay.

RESPONSESTO
INDIVIDUAL QUESTIONS

N.B. We have confined ourselves to responding to
questions of relevance to the Association.

What is the significance of any barriers or "market
failures" requiring the establishment of a Green Investment
Bank, and what are the risks of not getting this done quickly?

1. As identified by the Green Investment Bank
Commission in its recent report,[70]
there are four key market failures and investment barriers which
deter investment in low carbon infrastructure: market investment
capacity limits, political and regulatory risk, the confidence
gap, and the aggregation challenge.

2. Of these, the aggregation challenge is the
most significant in relation to investment in energy efficiency,
particularly as regards the buildings sector. This is because
household retrofitting consists by definition of a multitude of
individual investments and small scale projects. The GIB can play
a key role in aggregating these investment opportunities.

3. The potential for energy efficiency refurbishment
in the UK is enormous. A recent report by Ernst & Young[71]
identified that the cost of retrofitting the UK's 26 million homes
to a high energy efficiency standard would cost up to £225
billion between now and 2025. This broadly equates to the findings
of the UK Green Building Council (UKGBC), which concluded in its
August 2009 report[72]
that in order to finance a comprehensive package of home energy
improvements (as envisaged by the last Government in its Home
Energy Management Strategy), investment of between £5 billion
and £15 billion a year would be required through to
2020.

4. Despite this huge investment potential - and
the short payback times of many energy saving measures - householder
demand for energy efficiency improvements has failed to respond
to over 15 years of subsidy through successive supplier obligations.
A combination of factors is responsible for this. By and large,
householders lack high quality information on their energy usage
or about the potential for energy efficiency packages to save
them money; they also have limited access to appropriate sources
of capital. The situation in the UK compares poorly with that
in Germany, where the KfW Banking Group offers loans (backed by
Government bonds) to householders at a rate of 2.65%. The resulting
energy efficiency household loan programme is a resounding success
story - delivering 100,000 household retrofits every year.

5. Following on from the previous Government's
"Pay as You Save" proposals, the new Government has
announced its intention to use the forthcoming Energy Security
and Green Economy Bill to introduce a new Green Deal financing
framework, designed to incentivise householders and businesses
to invest in energy saving measures that "pay as they save".

6. However, a low interest rate will be essential
to the success of the Green Deal in delivering packages that pay
back in energy savings in their lifetimes. As the UKGBC report
on PAYS outlined, the ability of a package of measures to pay
back is very sensitive to the interest rate.[73]
The Government insists that all Green Deal energy saving packages
must meet the "Golden Rule" - in other words, that the
charge should be exceeded by the value of the fuel bill savings
over the lifetime of the charge. However, at commercial interest
rates it is unlikely that higher-cost measures (beyond cavity
wall and loft insulation) will be able to meet the Golden Rule.
If the Green Deal is to deliver "whole house" packages
of the kind that we need to meet our carbon reduction targets,
then the GIB must be enabled to play a significant role in maintaining
Green Deal interest rates at the lowest possible level.

Financing is not available to SMEs on terms that
make uptake attractive;

SMEs do not have the necessary technical knowledge
and confidence to invest.[74]

8. As identified by Ernst & Young,[75]
the sheer scale of the investment required in securing our low
carbon future is such that traditional sources of capital will
be able to provide only a tiny fraction of what is required. Their
analysis reveals that the UK needs a total of £450 billion
of investment in both supply-side and demand-side measures until
2025. Traditional sources of capital (utility companies, other
corporates, project finance and infrastructure funds) can only
provide approximately £50-80 billion over the same period.
This leaves an estimated funding gap for energy infrastructure
of around £370-400 billion over the next 15 years. The role
for the Green Investment Bank in plugging this gap is therefore
huge.

What are the objectives and roles the Green Investment
Bank should assume, what areas should it operate (and not operate)
in, and how should its lending and investment decisions balance
green benefits against financial risks?

9. Investment in energy efficiency should be
a key feature of the Bank's activities. In particular, we agree
with the Green Investment Bank Commission's conclusion that energy
efficiency should be given the highest priority in the Bank's
initial phase, as investment in demand reduction measures will
reduce the total infrastructure investment required and enable
the scaling-up of existing, proven technologies.

10. To deliver on our carbon reduction targets,
energy efficiency investment will be needed to finance not only
large-scale projects in the industrial and commercial sectors,
but also small-scale community projects and individual household
packages.

11. The Green Investment Bank Commission helpfully
outlined the ways in which the GIB might operate to overcome the
market barriers - for both households and SMEs - identified above.

12. For households, the main role of the GIB
should be to aggregate the multitude of small investment opportunities
that characterise the UK's retrofitting needs. But the GIB must
also be able to provide readily available upfront finance to householders
wishing to make significant energy efficiency improvements to
their home. We are attracted to the proposals put forward by the
Green Investment Bank Commission that this finance should come
from a public/private blended capital programme (funded in part
by green bonds raised by the GIB). This money would then be used
to provide upfront loans (as near 100% as possible) for the able-to-pay,
alongside near 100% subsidies for those unable to pay. A portion
of the publicly sourced funds would then be held by the GIB in
a "guarantee fund" and would be used to provide security
for loans taken out under the Green Deal financing system.

13. As outlined in paragraph 6, the GIB will
also have a key role to play in subsidising Green Deal interest
rates in such a way as to allow meaningful "whole house"
retrofits that include higher-cost measures such as solid wall
and under-floor insulation, and replacement windows.

14. As regards the SME sector, once again we
commend the Green Investment Bank Commission's suggestion that
the GIB should adopt a three-pronged approach towards addressing
the market barriers identified in paragraph 7:

Incentivising business investment via a graded variation
to business rates that ranges from a significant cut for the most
efficient buildings to a significant increase for the least efficient
buildings;

Building on the existing Carbon Trust SME loan scheme
to provide low-cost (6%) loans to SMEs for investment in energy
efficiency measures;

Providing independent guidance and assurance to SMEs
around the technology solutions that they implement.

What are the funding and governance structures
required to create an effective and accountable body, including
the role of "green bonds"?

15. It is vital that the GIB be given all the
tools necessary to enable it to drive forward the UK's successful
transition to a low-carbon economy. There are four key elements
that will be crucial to its success:

It must have a sufficiently wide mandate to enable
it to finance any measure that will reduce carbon emissions;

It must be established by statute in order to ensure
independence from the Government of the day. By the same token,
it should be accountable to Parliament, perhaps via an annual
report on its activities;

It should be adequately capitalised: Ernst &
Young[76]
recommend an initial capitalisation level of £4-6 billion
in the period to 2015;

It should have a full set of powers, including the
ability to issue green bonds, that will enable it to leverage
the required levels of finance from the private capital markets.
In other words, the GIB must have the full powers of a bank, rather
than simply be an agglomeration of existing Government "green
funds".

16. Finally, we believe that the new Coalition
Government should make a clear and early statement that it remains
committed to the creation of a Green Investment Bank (GIB). Although
this was promised in the Coalition Agreement, no concrete proposals
have subsequently been forthcoming. Furthermore, at the time of
the Queen's Speech on 25 May, the Government stated that the forthcoming
Energy Security and Green Economy Bill might be used as the legislative
vehicle "to set up a Green Investment Bank". We are
concerned that the latest pronouncements from the Department of
Energy & Climate Change make no mention of the Bill being
used for this purpose.

17. We are also concerned that a flurry of recent
media reports has pointed at significant Treasury resistance to
the establishment of a fully-fledged bank of the kind described
in paragraph 15. A limited fund designed merely to support a limited
range of projects (and unable to raise bonds) would be wholly
inadequate to deliver the levels of investment necessary to achieve
our low carbon future.